Why Stock Buybacks Are a Warning Sign for Smart Investors

Why Stock Buybacks Are a Warning Sign for Smart InvestorsLast year, the markets saw a record level of stock buybacks, led by some of America's largest companies. According to S&P's Howard Silverblatt, in the fourth quarter of 2010, S&P 500 companies increased their stock buybacks by 80.6% to $86.36 billion from $47.82 billion a year earlier. The leaders of the buyback pack are ExxonMobil (XOM), Walmart (WMT), and Microsoft (MSFT).

With the exception of ExxonMobil, these companies lack catalysts to propel them upward, and you should view their stock buybacks as an admission of defeat on the part of CEOs who lack the imagination to come up with growth investments. ExxonMobil ought to be able to find places to invest, but it benefits from rising oil prices, so it could still be a good investment.

Why are stock buybacks a problem? Their proponents argue that they return money to shareholders. But as I wrote last October on DailyFinance, many professional money mangers and investors interpret stock buybacks as a sign that company CEO aren't doing their most important job -- finding sources of new growth. If the best idea they can come up with is to funnel money back to shareholders, those company boards should replace the CEOs with people who have better ideas.

Primarily, stock buybacks are a shell game designed to boost CEO pay. Analysts look at the stock buybacks and realize immediately that they will reduce the number of shares outstanding, thus artificially boosting earnings per share. Since many CEOs get bonuses based on EPS increases, by giving money to the shareholders, they indirectly pave the way to higher bonuses for themselves.

According to Silverblatt, of the $86 billion in buybacks, the four biggest sectors are as follows:
  • Information technology (22.3%)
  • Consumer discretionary (15.9%)
  • Consumer staples (15.5%)
  • Health care (14.4%)
As far as individual companies go, here's a quick run-down on the top three stock repurchasers. I've looked at how much they spent on buybacks between 2004 and 2010 (out of an S&P 500 total of $722 billion), the stock performance during those years, whether EPS growth is a CEO bonus driver, and CEO compensation for 2010 and its growth from the year before. My conclusion is that with the exception of ExxonMobil, the CEOs are overpaid and underperforming. But at least these companies don't explicitly tie CEO compensation to EPS growth.
  • ExxonMobil bought back $152 billion worth of stock between 2004 and 2010. Its price rose 43% to $73.12 a share during that time. EPS growth is not a CEO bonus driver, and its CEO compensation fell 15.5% in the most recent year available, 2009 to $27.2 million.
  • Microsoft bought back $97 billion worth of stock between 2004 and 2010. Its price rose 4.5% to $27.91 a share during that time. EPS growth is a not a CEO bonus driver, and its CEO compensation grew 6% in 2010 to $1.3 million.
  • Walmart bought back $35 billion worth of stock between 2004 and 2010. Its price rose 2% to $53.93 a share during that time. EPS growth is not a CEO bonus driver, and in the most recent year available, 2009, its CEO compensation fell 32% to $19.2 million.
I think Exxon has further to rise because it will benefit from global demand for oil. But the other two have been unable to revive growth sufficiently to get their stock prices moving again. Their decision to pour cash into stock buybacks is a clear sign that they can't come up with big enough growth opportunities in which to invest. So you should keep your money away from their stocks.

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Dereck

Major Fraud Alert


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May 29 2011 at 12:27 AM Report abuse rate up rate down Reply
jbkdsk

I vote against all directors & executives who are for buybacks of their stock. I believe that if the company has that much extra money and no other company to buy, they should give that money to sharehoders as dividends. It is not fair to give it to themselves as compensation for doing nothing valuable for the company. When I ran my small company, I was always fair with my clients and because of that I was able to fund my retirement. Being honest and fair are the only way to succeed in my opinion.

March 27 2011 at 10:10 AM Report abuse +1 rate up rate down Reply
Gumby

Exxon merged with Mobil that shook Wall Street. When there is no growht opportunities, it mean maturity.. It doesnt mean the end of earning growth but it usually mean merger activity will likely happen... Once mergered, some smaller competitors will be smothered out, for sure.

March 25 2011 at 1:59 AM Report abuse rate up rate down Reply
Gumby

Stock buybacks are often preludes to merger activities .. You will see odd bed fellows!!!

March 25 2011 at 1:53 AM Report abuse +1 rate up rate down Reply
Gumby

Some companies try to grow organically into new areas . Maybe IBM and Microsoft will merge???? HP and Dell will merge?? AMD and Texas Instruments will merge?

March 25 2011 at 1:50 AM Report abuse rate up rate down Reply
Gumby

Now you are seeing late hot stocks going up so high without ever splitting shares at all. They learn from others' stupidness... Most of them understand that new competitors will usually rise and beat brains out of them so why split shares and end up flatlining then having to buy back shares . Some companies can make many successful acquistions to grow bigger and better match the outrageous amount of shares they had split in the years before.

March 25 2011 at 1:47 AM Report abuse rate up rate down Reply
Gumby

Stock buybacks are often the results of stock splits gone bonker! They can really simply reverse split shares to get the number of shares down.. They can give you four new shares for your five old shares... at no cost to them.. They buy back shares from large investors who are mindful about other large investors who will see stock price come down if they go directly to the market to sell. It is a cosemtic financing gimmick to get the best price for the stock while the other large investors can wait for their turns to dump stocks at stable prices without having to ask or bid for the price.. This is anti competitive... Read mutual funds... They swallow thousands of shares at once and couldnt regurigate them at once... and they need someone'shelp to buy back or regurgiate their shares out of their stomaches..

March 25 2011 at 1:40 AM Report abuse rate up rate down Reply
BobGrumbine

The wrongdoing CEOs who engage in "stock buybacks" only *pretend* that it is "returning money to shareholders". In fact all of the assets thus fraudulently transferred are going to stock manipulators for short term increases in market price of the shares. Makes the embezzlements of ownership via "stock options" worth something for the fraudulent CEOs playing the game. Meanwhile the Net Tangible Equity of the company, that which cash paid public *continuing* stockholders own, is being gutted and looted, in many cases making the companies doing the fraudulent transfers de facto BANKRUPT, i.e. Net Tangible Equity less than zero. Puffed up with phony bookkeeping entries such as excess of price paid over fair market value of assets acquired euphemized as "Goodwill" and other grotesquely intangible "assets" created to cover up the squandering of the real assets of the company for nothing of value to continuing stockholders, of course. But in many cases, it is an endless game of fraudulent transfers to criminal cronies in the stock manipulation business putting real stockholders, those who still own shares, deeper and deeper into negative valuations. Well, not quite endless as a rash of recent bankruptcies such as GM (an original greenmail payor years ago), WAMU (bankrupted itself and was closed by the regulatory authorities), and numerous smaller publicly owned companies has proven beyond a shadow of a doubt. So it isn't a "lack of imagination" on what useful thing to do with the money being fraudulently transferred. It is criminal corruption of Boreds of Die Rectors and CEOs with stock manipulators and other fraud and theft interests to whom all of everybody else's net worth is being transferred in those euphemized "stock buybacks" at ludicrous multiples of Net Tangible Equity, when any net worth at all remains.

March 24 2011 at 7:42 PM Report abuse +1 rate up rate down Reply
Shomara Cruz

I think Exxon has further to rise because it will benefit from global demand for oil.

See full article from DailyFinance: http://www.dailyfinance.com/story/investing-basics/why-stock-buybacks-are-a-warning-sign-for-smart-investors/19890317/#Comments?icid=sphere_copyright


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March 24 2011 at 4:39 PM Report abuse rate up rate down Reply